"July employment explosion, September interest rate cut by 50 basis points" - Is last summer repeating itself?

The sudden cooling of the U.S. job market is causing Wall Street traders and economists to recall the Federal Reserve's policy path from last summer.

At that time, the Federal Reserve chose to hold steady at its July meeting, but the subsequent release of a weak employment report quickly reversed the situation, prompting officials to take aggressive 50 basis point rate cuts as a "remedial" measure at the September meeting. Now, a similar script seems to be unfolding, with the market closely watching whether the Federal Reserve will "repeat its old tricks."

Currently, expectations for significant rate cuts are rising. According to reports from the trading desk, Citigroup predicted in a research report on August 1 that the Federal Reserve would cut rates by 25 basis points in September, but if the August employment data is similarly weak, the likelihood of a 50 basis point cut significantly increases.

It is worth noting that this year, the U.S. economy faces challenges different from those of last year. Despite weak employment data, the tariff policies of the Trump administration have raised inflation concerns, which were absent last year. The Federal Reserve needs to determine whether the economic slowdown is a temporary phenomenon or a long-term trend. Citigroup believes that with weak demand and a soft labor market, inflation risks are low. Before September, more employment and inflation data will determine whether the Federal Reserve will take decisive action.

Employment Data Deteriorates Across the Board, Clear Signals of Economic Slowdown

The latest July non-farm payroll data shows that the U.S. labor market is cooling at an alarming rate, far below market expectations. The number of new jobs added was only 73,000, and more concerning is that the employment data for May and June was significantly revised down by 258,000. Among them, the private sector added only 3,000 jobs in June and just 83,000 in July. The goods-producing industries, such as manufacturing, have seen a reduction of 13,000 jobs each month for three consecutive months. Job growth is highly concentrated in the healthcare sector, while other industries are performing poorly, with the leisure and hospitality sector adding only 5,000 jobs in July.

The unemployment rate rose from 4.117% to 4.248%, and the household employment survey showed a decrease of 260,000 in employment numbers. The labor force participation rate has declined for the third consecutive month, from 62.3% to 62.2%. Citigroup analysts pointed out that if the labor force participation rate remains unchanged, the unemployment rate would rise to 4.34% this month. In the past three months, the average employment growth in the United States has only been 35,000 people. Citigroup research even speculates through QCEW data that the actual number may be lower, with preliminary revised data expected to be released on September 9, which may show negative employment growth during this period. Additionally, the federal government has cumulatively reduced 84,000 jobs over the past six months, further highlighting the overall weakness of the job market.

Market Discussion: The Federal Reserve May Significantly Cut Rates in September

This unexpectedly weak employment report immediately sparked market discussions about the Federal Reserve's potential "holding steady in July and significantly cutting rates in September" scenario. According to a previous article by Jianwen, well-known financial journalist Nick Timiraos, known as the "new Federal Reserve correspondent," stated that this scene feels "familiar":

Last year, Federal Reserve officials decided not to cut rates at the July policy meeting, but the employment report released two days later showed that the labor market was not as strong as it appeared. Ultimately, the Federal Reserve "caught up" by lowering rates by half a percentage point (more than the traditional quarter percentage point) at the September meeting.

This week, the Federal Reserve also chose to hold steady, but the employment data released on Friday showed an unexpected cooling of the labor market in recent months. Traders raised the probability of a rate cut in September from 38% on Thursday to over 70%.

Data from the Chicago Mercantile Exchange shows that the probability of the Federal Reserve cutting rates at the September meeting has surged from less than 40% on Thursday to nearly 90% (with a probability of a 25 basis point cut as high as 89.6%). Although the current futures market indicates that traders believe the probability of a 50 basis point cut is zero, expectations for a significant rate cut are heating up.

Citigroup currently maintains its baseline forecast that the Federal Reserve will cut rates by 25 basis points in September and will continue to cut rates by 25 basis points at each subsequent meeting until reaching a terminal rate of 3.00%-3.25% by March next year. However, Citigroup analysts believe that the risk balance leans towards a more accommodative policy. If the August employment report is similarly weak (for example, if the unemployment rate rises to 4.5%), it could trigger a 50 basis point cut.

Can History Simply Repeat? Inflation Concerns Are the Key Variable

However, Timiraos also noted that there is a key difference between this year and last year: last year, U.S. inflation was in a sustained decline, while this year, due to a series of broad tariffs implemented by the Trump administration since spring, Federal Reserve officials are concerned that inflation pressures may resurface.

Therefore, Timiraos emphasized that the key question facing the Federal Reserve is: Is the fundamental economic situation in the United States truly deteriorating, or is the recent slowdown merely a temporary phenomenon caused by the lagging effects of certain policies? **

Citigroup analysts expect that in an economic environment of slowing demand and a loose labor market, the risk of sustained inflationary pressure is minimal, which will alleviate concerns about tariff-related inflation. If the weakness in growth and the labor market persists for a longer period, officials may lower interest rates below 3% next year.

Before the September meeting, policymakers will also receive an employment report and two months of inflation data, which will collectively determine whether the Federal Reserve chooses to take a cautious wait-and-see approach or respond to the changing economic outlook with a decisive action like last year